 The Synthetic Lease Dilemma
Synthetic leases have received a much higher profile in the last few months, but that profile has been far from positive thanks to the continuing fallout and concern about off-balance sheet accounting treatments resulting from the collapse of Houston-based Enron. In fact, many observers consider the synthetic lease vehicle dead for the foreseeable future because corporations are unlikely to embark on any strategy that will involve placing real estate assets into a Special Purpose Entity (SPE), and off the balance sheet, as is the case in a synthetic lease. The current climate on Wall Street and among the investing public just won't allow it. In many markets, the underlying property value has dropped - exposing companies holding synthetic leases to additional financial liability. Add to this the fact that the Financial Accounting Standards Board (FASB) is now reviewing the rules regarding the accounting treatment of synthetic leases - FASB is due to make recommendations for public comment in May - and there is a great deal of uncertainty regarding this financing tool. What remains to be answered though, is what will happen to the billions of dollars worth of synthetic leases that already exist. For most of the latter part of the 1990s, when the U.S. economy was going through a prolonged period of expansion, synthetic leases were the financing tool de jour for corporations seeking to fund the construction of new facilities. As the steamrolling economy fuelled corporate expansion, companies looked for ways to liberate their balance sheets, freeing up capital to help the expansion effort. Taking their real estate assets off-balance sheet via a synthetic lease was one way of doing this. Synthetic lease structures are incredibly complex. However, the end cost of financing is often cheap enough to make them worthwhile. It has not been unusual to see deals priced at less than 2% over LIBOR or 4 to 5 percent, less than half the cost of other vehicles such as traditional sale/leasebacks, where rates typically run significantly above 10 percent. Time to Pay the Piper?
It's not clear if the FASB recommendations would trigger the need to unwind synthetic leases already in place or allow for a grandfathering of existing synthetic leases. What is clear is that any change to FASB rules will result in a significant amount of activity in the area of synthetic leases. No one really knows how much corporate real estate is held today in the form of synthetic leases. What is known is that because many of these leases were executed in the mid to late 90s with terms ranging from three to seven years, there is likely to be a wave of deals coming onto the market in the next 24 months, even without changes to FASB rules. There has already been an uptick in the number of real estate funds announced specifically to invest in excess corporate real estate and many of these funds may also be available to acquire and leaseback facilities currently owned through synthetic leases. Last month, Cohen Asset Management and Chanin Capital Partners, both Los Angeles-based investors, announced the formation of such a fund, St. Pierre Real Estate Liquidity Fund. The ultimate cost of unwinding a synthetic lease and executing a more traditional transaction such as an outright purchase or sale/leaseback, may be far less onerous on a company than the potential hit to a stock price that could come from analysts and investors balking at the presence of complex synthetic leases and other off balance sheet vehicles. The fact remains that many corporations will have some tough strategic decisions to make during this time since general real estate market conditions have changed markedly in the intervening years since many of these leases were constructed. It is up to corporate finance executives and their real estate advisors to carefully weigh all of the options, craft a strategy that dovetails with the company's financial position and then execute an appropriate transaction. As some companies who executed synthetic leases in the 1990s have already discovered, what seemed like a good idea at the time, can sometimes come back to hurt the corporation. Email Ed Lubieniecki,director of consulting for New York City-based Grubb & Ellis. |